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Stocktake: Rising risk of ‘melt-up’ in five-year US bull market

Tue, May 21, 2013, 02:00

Proinsias O'Mahony

Proinsias O’Mahony

THE five-year US bull market is gathering momentum. It’s now over six months since the S&P 500 pulled back by 5 per cent – the longest run since the bull began in March 2009. Up over 15 per cent in 2013, the index has “pretty much been trading in overbought territory all year now”, Bespoke Investment Group notes, and last week hit its most technically overbought level in more than a year.

Nine of 10 sectors are overbought; over 90 percent of stocks trade above their 50- and 200-day moving averages; the overall index is 12 per cent above its 200-day average; and stocks now trade at a price-earnings ratio that is over 40 per cent higher than it was in October 2011.

Merrill Lynch’s Michael Hartnett reckons there is a “high and rising” risk of a “melt-up” in stocks. “Positioning, price-action, policy and a range-bound economy can conspire to cause an overshoot”, he says, the risk being that this might then trigger swift corrective action from the Federal Reserve, which has pumped trillions into the economy.

As Warren Buffett cautioned recently, the Fed’s eventual withdrawal of stimulus will be “the shot heard around the world”.

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CAN’T wait any longer for that pullback? Just buy on a Tuesday – for the last 18 Tuesdays, the Dow Jones Industrial Average has risen every time. The winning streak began on January 15th, with the Dow since rising by more than 1,700 points. Over 1,400 of those – more than 80 per cent – have been added on Tuesdays, Bespoke Investment Group notes.

Such a winning run is unheard of over the last century, breaking the previous record (15) set back in the 1920s.

In the UK, Tuesdays have been bullish for some time, says the
UK Stock Market Almanac
. Since 2000, when the market has fallen on a Monday, the following day’s returns have been five times greater than average.

Klarman, whose annualised returns of 20 per cent over the last 30 years have made his Baupost Group hedge fund one of the biggest in the world, bought more than nine million Elan shares in the last quarter, according to a quarterly filing released last week.

The purchase prices were between $9.40 and $12, with an average price paid of $10.85 per share. Elan was Klarman’s biggest purchase in the last quarter, the stock making up 3.5 percent of his US long portfolio.

It’s a vote of confidence in Elan. A classic long-term value investor, Klarman seeks out bargain-basement material, and is content to sit tight until opportunities present themselves – currently, more than a quarter of his portfolio is in cash.

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INVESTORS should take money managers’ public utterances with a pinch of salt, as last week’s release of 13F quarterly filings shows.

Take octogenarian billionaire Julian Robertson. Last October, he recommended Apple*, then trading at around $600, saying: “It’s rare that you get a chance at having a great company at a great value”.

Far from adding to his Apple position in recent months, however, he bailed out, dumping his entire stake in the company in the last quarter, the filings reveal.

Another billionaire, Third Point’s Daniel Loeb, said last January that investment bank Morgan Stanley, then $20, could “nearly double”. The stock rallied to above $24 in February before slipping back to $21 at the end of March. Far from waiting for $40, however, Loeb had said goodbye to the stock.

Loeb also predicted in January that controversial nutritional firm Herbalife could hit $68, describing it as a “compelling long-term investment”. A month later, with Herbalife having rocketed from $25 in December to a high of $46 in January, reports emerged of Third Point selling. At the end of March, Herbalife was trading at $37; by then, Loeb had dumped all his shares.

Moral? Beware free tips from billionaires.

* Disclosure: The author holds shares in Apple

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WIKIPEDIA usage patterns can indicate early signs of stock market moves, according to a new study.

The study, which covered the 2007-12 period, analysed Wikipedia page views of the 30 stocks that make up the Dow Jones Industrial Average, with search increases typically pre-dating market falls. Similarly, trading strategies based on an increase in page views of topics related to finance yielded returns that were “significantly higher” than that yielded from random strategies.

Why? People are loss averse, and are “more concerned about losing £5 than they are about missing an opportunity to gain £5”.

People will invest “more efforts in information gathering before making a decision which they view to be of greater consequence”, so it follows that “increases in information gathering would precede falls in stock market prices, in line with our results”.

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